Why should Mitt Romney and the fabled “one-percent” pay only a 15% marginal tax on investment income … half the rate charged to a dentist or auto mechanic on wages earned from work? This was not the case until recent Republican Congresses slashed taxes on passive, unearned dividends and capital gains.

The rationale for that immense tax cut for (mostly) rich investors was simple and alluring – that super-low rates would entice more of the rich to invest in companies within the U.S., helping them to increase their productive capacity and hire more workers. Moreover, the resulting boom in economic activity would then result in so much new tax revenue, even at low rates, that deficits would disappear.

Let’s put this in context with a term you may have heard. “Supply side” economic theory maintained that this flow of investment capital would pump up the factory end of things, increasing the supply of goods and services, offering them cheaper, thus stimulating demand.

In contrast, the standard Keynsian “demand side” model was to fight recession by ensuring that poor and middle class folks had enough cash (“high-velocity” money) in their pockets to buy – or “demand” – goods and services. Whereupon producers would be drawn into greater production.

For a more detailed description of the differences between these two economic models, see my earlier missive A Primer on Supply-Side vs Demand-Side Economics. (It really is one of the top issues of our day and an informed citizen should know about it.) Here in this place, I’ll try to be brief.

Once upon a time…

Who was right? Blatantly, the Keynsian approach worked in the 1940s, when massive government spending on WWII resulted in a boom that ended the Great Depression. A boom that then continued for 30 years, till Vietnam crushed it against a wall. Throughout that period, high tax rates and stimulative spending seemed to work, whenever the economy needed a little help. Moreover, during that era, a very flat social structure – (CEOs earned only a few times what factory workers did) – combined with the most rapid growth of the middle class and the most vibrant era of startup capitalism in human history.

That does not make Keynsianism perfect! Critics like Friedrich Hayek, have indeed exposed some faults and blunders that later Keynsians, like Paul Krugman, openly admit and have striven to correct. Still, the Demand Side approach can point to many clearcut successes.

In particular, it is plain that during recessions, when economic activity lags and deflation looms, what you want is “high velocity” money in circulation – money that will pass from buyer to seller and then to another seller and so on. Not money that just sits.

Does Supply Side have a similar track record? Not even remotely. Not even once. Simple charts – and hard conclusions from the Congressional Research Service – show that the Supply Side assertion was… and is… utter mythology. None of its predicted effects ever happened. And let me reiterate. Not ever, even once.

Regarding supply-side economic theory, the author states, “Their experiment has been run, now, for more than three decades, and never once has their core predication come true… that cutting taxes on the rich will result in increased overall revenues and a vanishing federal deficit.” This is a straw man.

The fact is this: that as the Reagan-era Kemp-Roth income tax cuts were phased in over three years, revenue to the Federal treasury grew by substantially more than the static economic models used by the Congressional Budget Office (CBO) predicted. This makes intuitive sense.

The premise of the supply-side economics and the Laffer Curve isn’t hard to understand. At tax rates of both zero and 100%, government revenue would be zero with there being some optimum range to maximize revenue – further, to the extent that lower levels of taxation encourage economic activity, the economy will grow at a more rapid rate, thus increasing the base from which government draws taxes. This concept was considered so elemental that Ibn Khaldun, an Arab scholar writing in his book Al Muqaddimah” (“The Introduction”) in 1377, thought it common sense: high taxes destroys economic activity which destroys the state.

Back to the author’s straw man. Revenue did grow after the tax cuts by a substantially greater amount than the critics said they would. The reason for the deficits wasn’t a lack of revenue. Rather, then, as now, deficits are due to the rate of spending increases exceeding the rate of economic growth.

Look it up. The data is easy to find.

Jeremy Bloom

Sorry, Chuck, but it doesn’t work that way. You don’t just get to make a completely baseless statement like “The fact is this: that as the Reagan-era Kemp-Roth income tax cuts were phased in over three years, revenue to the Federal treasury grew by substantially more than the static economic models” without some sort of reference.

Simply saying “Look it up. The data is easy to find” doesn’t cut it.

You want to win an argument, you come to the table with a lot more to back up your “facts” than a simple “because I say so”.

Mark Boundy

Jeremy, Chuck is right, a little bit: during the Reagan era, we experienced an economic expansion that increased tax revenue. Chuck, you are only right a little bit: the Reagan budget deficits were, at the time, the biggest in our nation’s history, fueled by good old fashioned New Deal pump priming: a massive spending binge. While you may applaud the freedom-loving/evil-squashing/God-Bless-America reasons for this huge spending blitz, the fact remains that it was pure Keynes (who ironically published his most famous work the year after the Gipper got a C- in his only econ course at Eureka Junior College). I disagree with the author a little bit: I maintain that supply side has never been tried, because we always seem to find a reason to lob a wad of massive spending into the mix in order to make sure of the result (Reagan held the record for biggest deficits in the nation’s history until George W. crushed him).

Chuck, your discussion of the Laffer curve is cogent, correct, and valid at the top portion of the curve. Now look down. What happens at lower tax rates? That’s right, revenues go down. The same logic that applies at a 95% marginal rate does not necessarily apply at a 50% rate (or more accurately, the logic explained in the full theory — the part politicians seem to lose interest in before getting to). Or a 39% rate, or 15. Measurements show that we are faaar away from the decreasing total revenues part of the curve, and were in the Reagan era as well.

Imagine standing behind Albert Pujols at batting practice with a great BP pitcher in a hitter’s park — with a wand in your hand that you wave and say “abracadabra” every time he connects. Do you really think the reason the baseball left the field was the magic in the wand?

Does your answer change if the wand is painted “supply side red”?

Are you sure?

Jim Myrtle

“Instead of enticing the rich to invest, these super low dividend and capital gains rates simply used money taxed from middle class wage-earners to give bonuses for speculations wealthy folks were doing anyway”

Let’s pretend the capital gains tax rate is 20%.
Now let’s pretend evil conservatives cut the rate to 15%.
How does that reduction “use(d) money taxed from middle class wage-earners to give bonuses for speculations wealthy folks were doing anyway”?
Please show all your work.

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